Suppose the U.S. economy is operating above full-employment equilibrium, which leads to significantly high demand-pull inflationary pressure (see Figure 3). The government plans to use the fiscal policy instruments to close the inflationary gap by shifting the aggregate demand curve. Mindful of this government strategy, answer the following questions on the use of fiscal policy tools during the inflationary gap.
What is the type of fiscal policy the government uses to close the inflationary gap?
What are the two fiscal policy instruments available to the policy makers in this respect?
What are the effects of these policy actions on the AD curve, price level and the real GDP? Analyze the effect of each policy tool on these macroeconomic variables.
What are the four methods the government can use to balance the budget? Examine each of the methods.
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